Lloyds, RBS to swell U.K. government debt levels

But real concern lies with deteriorating public finances, economists say

By

WilliamL. Watts

LONDON (MarketWatch) -- The official measure of British government debt will rise by as much as 1.5 trillion pounds ($2.1 trillion) after the Office for National Statistics confirmed Thursday it would classify Lloyds Banking Group and Royal Bank of Scotland as public-sector entities.

That means net liabilities of 1 trillion to 1.5 trillion pounds, equal to 70% to 100% of gross domestic product, will be added to the measure of U.K. public sector net debt. The change is effective from Oct. 13, 2008, when the government moved to recapitalize the troubled institutions.

The banks join lenders Northern Rock and Bradford & Bingley, who also hold the same classification.

Economists said the change to the figures would likely exaggerate taxpayers' exposure to bank liabilities. A deteriorating picture for public sector borrowing is a bigger worry, they said.

The ONS, meanwhile, said figures from the two banking groups will be incorporated into data on public sector finances "as soon as is practicable, but it should be noted that they are large, complex organizations, and this may take some time."

Public debt stood at 703 billion pounds in January or 47.8% of gross domestic product.

The U.K. government has pumped 17 billion pounds into Lloyds Banking Group and holds a roughly 43% stake in the company. The government has also pumped around 20 billion pounds into RBS and will hold a roughly 70% stake once preference shares are converted.

Economists deemed it questionable whether the metrics usually used to gauge manageable levels of public debt remain relevant when banks are brought under public control.

That's because net debt is calculated by subtracting liquid assets from total liabilities -- and banks, by the nature of their business, carry relatively few liquid assets as a proportion of their balance sheet, said Simon Hayes, an economist at Barclays Capital, in a research note. The measurement, meanwhile, ignores illiquid assets, such as loans to corporations and households, that do have value and will generate cash flow over time.

Also, since no government is likely to let a major bank collapse, it's rather arbitrary whether a bank's liabilities are included in public finance statistics, he said.

"When push comes to shove, the public finances of all major economies are vulnerable to any further deterioration in banking sector prospects, whatever the official net debt figures might say," Hayes said.

Meanwhile, January borrowing figures showed U.K. public sector finances were in worse shape than expected, with the public sector repaying just 3.3 billion pounds in public borrowing compared to forecasts for a repayment of around 7.5 billion pounds. That marked the smallest repayment in 14 years.

January typically sees a big repayment because it is a major month for income and corporate tax payments.

For the 2008-09 financial year to date, the budget deficit stood at 42.5 billion pounds at the end of January, up from 7 billion at the same point in the 2007-08 financial year. Public sector net borrowing totaled 67.2 billion pounds to date, up from 23.1 billion at this point in 2007-08.

The British pound was unfazed by the news, rising 1.3% versus the dollar to $1.4408 in recent action. Sterling has fallen sharply since the middle of 2008, however, in part due to mounting concerns over the government's deteriorating fiscal picture, economists said.

The pound traded just below $1.90 in late September.

Economists said the deteriorating public finance picture underlines a growing worry for the U.K. economy.

"As the deficit rises, [Chancellor of the Exchequer Alistair Darling] may well need to find a way of further convincing the markets of the U.K. government's credibility - with the possibility of further future spending cuts and/or tax rises," wrote Charles Davis, an economist at the Center for Economic and Business Research, a London think tank.

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